If you own a limited liability company, you’ll probably run your business without thinking much about ownership issues. However, even if you only have a couple of shareholders and/or directors, it’s important to understand the difference between their rights and duties. This is because decisions made about share ownership while businesses are small or growing can have a big impact later on.
If you and your business are new to shareholding and the powers of shareholders, our corporate solicitors are here to explain how shareholders’ rights work in practice.
- Brief overview of shareholders’ rights and liabilities
- Classes of shares
- Shareholders’ voting rights in detail
- Rights to receive dividends and preference shares.
- Differences between private and public company shares
- What documents do you need to create and vary shareholders’ rights, and how do you go about creating them?
Brief overview of shareholders’ rights and liabilities
First, a word on shareholder rights and liabilities.
Any shareholder normally has the right to participate and vote in ‘general meetings’ of the company. For example, there will be a meeting of the shareholders to make decisions about the company as a legal entity, such as the location of its registered office and the number and classes of shares. Decisions about the day-to-day running of the company are taken by the directors in board meetings.
Shareholders’ liabilities are limited to any amount they still owe for their shares. If the company is insolvent, they may not get their original stake back. If the company is wound and solvent, the shareholders will receive back their initial capital, pro rata to their shareholding.
Classes of shares
If your business is a UK limited company, you probably chose to have a single class of ordinary shares when you set it up. The rights that go along with those shares are described in the company’s Articles of Association. Your shareholders may include your co-founders, friends and family members.
As companies grow, their owners sometimes create different classes of shares so that they can give different rights to the holders of each class. What seemed fair when starting out may seem inflexible or inappropriate now. For example, you may want to treat your original shareholders differently from outsiders who have given you financial backing in return for shares, or your funders may insist on it.
Alternatively, you may like to offer share incentives to your employees as part of their package, but not want them to be able to vote on company business. You may be looking for finance, but not want your backers to be able to vote or attend company meetings.
You may also feel that someone’s right to vote be ‘weighted’, because of their knowledge or status in the business, or want to give them different rights to receive dividends or receive their stake back if the company is wound up.
When you create classes of shares in your company, one person may hold different classes of shares. For example, that person may have ‘A’ shares that give them certain benefits, as well as ‘B’ shares that give them others.
So, a company can choose to have different share classes to:
- Give different shareholders different rights to dividends. For example, the right to receive dividends before other shareholders (preferred shares), or to receive dividends only if certain conditions are met (deferred shares)
- Give voting rights to only one class of shares, or restrict (or add) voting rights to one or more classes of shares. For example, if you want to raise finance but want to keep majority control of your company
- Create a class of shares whose ownership and rights attach to a single group of people, such as family members or employees, who won’t be able to vote or attend general meetings
- Give certain shareholders preferential treatment when it comes to receiving payment for their shares if the company is wound up
Shareholders’ voting rights in detail
The company decides what voting rights are attached to each share. The options available are as follows:
- Full voting rights
- No voting rights
- Voting rights in certain specified circumstances
A shareholder normally has the right to vote on decisions about the way a company is structured, for example, the number and classes of shares. These decisions are made in general meetings of the company to which shareholders are invited and may vote. If you want to vary these rights, you need to change the Articles of Association.
If you want some shareholders to be able to have an influence or veto on matters of company business (this is normally the prerogative of the directors), then you wouldn’t do this just by creating classes of shares, you’d need a shareholders' agreement as well.
Shareholders’ agreements can also give more protection for minority shareholders, as they cannot be changed without all the parties agreeing. The Articles of Association, in contrast, can be changed by a 75% majority.
By putting special voting rights in a shareholders’ agreement, holders of a certain class of shares can. For example, influence or block the directors from taking important decisions affecting the company’s business without their consent.
Special voting rights may include:
- A right to appoint or influence the appointment of directors
- A right to have a say in the business operations
- An influence on the pay of directors
- A right to be informed or consulted before a company takes a particular action, such as borrows large sums of money, mortgages property or changes its business plan
- A right to additional or weighted votes on certain important matters
Rights to receive dividends and preference shares.
If a company is profitable, the directors may decide to pay dividends, known as a share of those profits, to the shareholders. If there are no classes of shares other than ordinary shares, each shareholder will have the right to receive a proportion of those dividends pro rata to their percentage ownership.
If you create different classes of shares, you can attach different rights to receive dividends to each class.
You can also create a class of shares known as ‘preference shares’, that give the holders the right to receive a fixed annual dividend before any other class of shareholders, or a certain proportion of the company’s profit in any given period. These are usually non-voting, and issued to employees or investors, so that you can reward them or raise finance without giving up voting control.
Here’s an example of several classes of shares, each with different rights, including a preferential right to repayment of capital on a winding up of the company:
|Nominal value per share||Voting rights||Dividend rights||Right to capital on winding up|
|Ordinary ‘A’ shares||£1||One per share||Equal rights to dividends||No right to payment unless ‘B’ shares have been paid in full|
|Ordinary ‘B’ shares||£1||Non-voting||Equal right to dividends||Preferential right to payment|
|Preference ‘C’ shares||£50||Non-voting||7% preference share carrying a dividend of £3.50 per share each year||Only have right to capital once ‘B’ and ‘A’ shares have been paid|
Sometimes in a high-growth business that isn’t yet profitable, a company may create a share class that has a cumulative right to a dividend that rolls up until the company has enough available to pay them.
Differences between private and public company shares
The main difference between private and public companies is that shares of public companies are offered for sale to members of the general public. Private companies frequently raise capital by ‘floating’ their shares on the stock exchange in an IPO.
Owners of shares in public companies have the same rights to vote as those in private companies and may receive dividends if the company is profitable. However, given the large number of shares issued, unless they are an institutional investor with a large number of shares, their voting rights are not usually significant.
What documents do you need to create and vary shareholders’ rights, and how do you go about creating them?
Shareholder’s rights are described in the Articles of Association. If you want to create new rights, or vary existing rights, you have to change them.
Classes of shares are often created in the context of wider changes to the company’s business, like setting up a joint venture, refinancing, giving out share options or scaling up.
Because these transactions can be complex, in addition to changing the Articles you would normally have a shareholders agreement as well, to reflect the changes. You should use a legal advisor to help you draft one.
Any fundamental change to shareholders’ rights made in a shareholders agreement must also be reflected in the Articles.
The process for creating new classes of shares is as follows:
- Check that the Articles of Association allow for the creation of new share classes. Usually, they do, but you still need to amend them to reflect the new arrangement
- Check that there are no existing agreements such as shareholder agreements that would stop you from setting up a new share class
- Hold a general meeting to create the new classes of share and amend the Articles of Association
- File the amended Articles and a copy of the shareholder resolution at Companies House
- Allot the new shares
While it’s relatively simple to start a company, investing time in the paperwork can pay dividends later, especially if yours is a jointly owned and controlled business. However well you get on at the start, fall-outs can happen, and when companies are run by individuals (or companies) 50/50, gridlock can happen as neither has the power to make a decision alone. So, what methods can be used to resolve shareholder deadlock?